Dundee Report...skipping company history, mgmt tea Investment Thesis-A Call Option on the Met Coal Market
CMK offers leverage to a rebound in the metallurgical coal markets given that the company's key asset, the New Elk mine, is fully built and has a solid long-term production profile. Although we view Cline as undervalued at present levels, we currently have no clarity on production and revenue going forward given CMK's inability to contract sales. Further we await a new mine plan from the new operating team who joined CMK from Xstrata in May. We expect that this should come out within the next 60 days.
We view a mine like New Elk, with a 30+ year life, as a potential target for consolidation in the sector as larger miners are looking to secure enduring production in stable jurisdictions.
Cline Mining is a Toronto-based metallurgical coal producer focused on the 100%-owned New Elk coal mine in Trinidad Colorado, USA, a historic coal mining region. The New Elk Mine, CMK's key asset, boasts an M&I resource of 618.9mm tons of low-sulfur, high-volatility, coking coal capable of supporting a 30+ year mine life. Because of weak coal markets, Cline’s current priorities are: preservation of the company's financial position, achieving sales contracts and cost efficiency.
Production at the New Elk Mine started in 2012 and coal contracts are currently being sought. Cline is in a position to commence full commercial production and ramp up to a 3.0mm tons per year run-rate once sales are confirmed. Cline's coal will be transported by train to the Port of Corpus Christi Authority in Texas where it can be shipped to global customers. Although Cline has not contracted any coal sales to date, the company remains cautiously optimistic about the long term coal market potential and is well positioned to quickly take advantage of a recovery in the coal market.
Having started production in Q2 of this year, Cline was in the process of ramping up to its 3mm tpa nameplate capacity at the New Elk Mine. Due to the present lack of sales, we have conservatively modeled 2012 production at 70k tons of coal (the amount currently stockpiled) and have Cline hitting the 3mm ton target run-rate sometime in 2015. Coal production at New Elk is presently driven by sales rather than production capacity. At full capacity the New Elk Mine will run 10 continuous miners, and mine 5 super-sections simultaneously. Ech super section would have capacity to produce 500- 600ktpa of saleable coal for total production of 2.5-3mm tpa. Cline's coal is characterized as high-volatility, low-sulfur, high- ash coking coal. Due to elevated ash content, we believe that CMK's coal will receive a discount to benchmark coking coal prices. We estimate Cline's average FOB production cost to be approximately $105 per ton and that Cline will receive an average price of $135 for its product-a ~20% discount to the benchmark hard coking price.
Using a long term benchmark coal price of US$180/tonne and a 10% discount factor, we estimate CMK's NAV to be $341mm or $1.46 per share on a fully diluted basis. The New Elk Mine accounts for 84% of CMK's NAV; balance sheet items account for the remaining 16% of our valuation. We believe that our NAV is conservative as it does not take into account CMK's other assets or Cline's option to expand production capacity at New Elk, however, we cannot reliably predict when coal sales will be achieved. At CMK's current price the stock is trading at 0.24x NAV compared to our coal universe average of 0.37x, we believe that this discount is unwarranted given CMK's long-term production profile.
Cline will be in survival mode for the next 12 months or until it makes coal sales. During this time CMK will make efforts to conserve cash and to pursue strategic partnerships. CMK has $50mm in debt on the balance sheet at 10% interest, due at the end of 2014. We believe that CMK has enough cash to survive the 12 month retooling period with $16.9mm cash on hand and ~$1mm per month cash burn rate during the period.
At current trading levels we view CMK as a good opportunity for leverage on rebounding met coal markets. Further CMK's long-term production schedule makes it a possible takeover target.
We are initiating coverage of CMK with a BUY recommendation and a 12-month target of
.90/share based on a 0.7x multiple to our NAV of $1.27/share. This target price also represents a 3.0x 2014 EPS multiple and a 0.55x EV/2014EBITDA multiple. Once CMK has contracted coal sales and can consistently generate revenue we will move away from the NAV approach and base our valuation on an EV/EBITDA multiple.